Question

Upon graduating from college, you take the proceeds from your successful shirt company and begin a company that sells foreign securities in the United States (to save money on stationery, you keep the same acronym by calling your new company Traditional Client Investment Service [TCIS] Company). Part of your task is to provide a newsletter to clients discussing the return on foreign securities. Fill in the blanks in the following newsletter. Currently, a one-year bond denominated in dollars pays an interest rate of 6 percent. A bond that is denominated in won, and has similar characteristics in terms of risk and liquidity, pays 7 percent.
This means that the implicit forecast by the foreign exchange market is that the dollar will (appreciate/depreciate) against the won over the next year by ___ percent. This month, it takes 1500 Korean won to buy one dollar. TCIS forecasts that next year at this time it will take 1575 won to purchase a dollar. This represents (an appreciation/a depreciation) of the dollar against the won of ____ percent.

Based upon our forecast, (we advise against/we advise) purchasing won denominated securities. The reason for this is that

Answer 1

This means that the implicit forecast by the foreign exchange market is that the dollar will appreciate against the won over the next year by 0.94% (((1 + Won Interest)/(1 + $ interest)) - 1 = 1.07/1.06 - 1= 0.94%) . This month, it takes 1500 Korean won to buy one dollar. TCIS forecasts that next year at this time it will take 1575 won to purchase a dollar. This represents (an appreciation/a depreciation) of the dollar against the won of 5% [(Forward rate - Spot rate / Spot Rate) = (1575-1500) / 1500].

Based upon our forecast, we advice against purchasing won denominated securities. The reason for this is that the value of won is depreciating more than the implicit rate of 0.94%

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